Both improved economic global growth or the failure of central banks’ extraordinary monetary policies are likely to have negative impacts for equity markets, according to FE Alpha Managers Steve Russell and David Ballance, who warn that neither outcomes “are particularly attractive” given their potential repercussions. 
A number of market commentators have warned that 2016 will usher in the end of the seven year bull-run in equity markets as valuations have risen, corporate earnings have showed signs of waning, macroeconomic uncertainty has increased and central bank actions (which have fuelled the rally) are seemingly running out of steam.
The past 12 months or so have largely backed up this hypothesis as well, with the likes of the MSCI AC World and other regional indices in negative territory.
Performance of indices over 1yr
Source: FE Analytics
Much has been made of the future direction of risk assets, however, as while certain brokers argued investors should look to “sell everything” in January following further negative developments in China and another fall in the oil price, equities rebounded strongly once again in February.
The MSCI AC World index rallied some 18 per cent between 11 February and 14 April. However, global equities have been on a downward trend ever since and Ballance and Russell – who co-run the CF Ruffer Total Return fund – say this is the beginning of a very difficult period for equity markets.
“We have previously remarked, only partly in jest, that in a world where zero interest rates (or even lower) are the norm, eventually the return on other financial assets might turn out to be zero too,” the managers said.
“Which may explain why so many previously successful hedge funds have thrown in the towel. It is of course too early to pass judgement on what might happen through the remainder of this year, but stock markets appear to be doing their best to adhere to this rather depressing roadmap.”
“After earlier sharp falls most equity markets have made their way back to par, aided by either soothing words or inaction from central banks, but they show little enthusiasm for further gains.”
Russell and Ballance are certainly not the only managers to be cautious at the moment.
Indeed, the latest BofA ML Fund Manager Survey found that professional investors are positioning for a “summer of shocks” with cash balances across the world nearing record high-levels.
Average cash balances of global asset allocators
Source: BofA ML Fund Manager Survey
The survey showed also showed 58 per cent of the fund managers say they are now bearish towards equities on a 12-month view, a record low for the survey. What’s more, the allocation to equities has fallen from a net 9 per cent overweight to a net 6 per cent and 89 per cent are saying stocks look overvalued.
The Ruffer managers have long-held the view that experimental policies from the world’s central banks – in the form of ultra-low as well even negative interest rates and quantitative easing – have done little but distort financial markets due to excess liquidity.
Russell and Ballance now argue that, given investors have been so used to very loose monetary conditions, central banks are cornered as even if they manage to start tightening the market will react badly.
“Tempting as it is to declare premature vindication of the zero return hypothesis, a more likely explanation lies in investors’ uncertainty as to whether we face the perceived failure or normalisation of monetary policy. Unfortunately neither path appears particularly attractive,” Russell and Ballance said.
“If global growth is strong enough to bear higher interest rates (initially in the US) then dollar strength and rising discount rates may undermine short term prospects for equities.”
“If monetary policy is seen to have failed, the progression to the likely next step, fiscal intervention, is fraught with dangers against which, in our view, only inflation-linked bonds stand sentry.”
The managers say there is no better evidence of this dynamic than within Japan, which has been their preferred equity region for some time now despite the fact the Nikkei has failed to make any real headway against global indices over the past three years.
Performance of indices over 3yrs
Source: FE Analytics
“Bank of Japan Governor Kuroda must feel he cannot win, whichever way he turns. His imposition of negative interest rates earlier this year received a resounding thumbs down from markets (equities down, yen up), so in response he sat on his hands in April, only to be greeted by the same negative reaction,” they said.
The Ruffer managers admit that this has “tested their resolve” with Japanese equities – which is their largest regional exposure at 15 per cent – but they have continued to hold onto their position.
“We believe such perceived policy missteps will merely hasten the path to more fiscal intervention. This could perhaps come as soon as the G7 meeting hosted in Tokyo at the end of May and could be the catalyst for a recovery in a market that is both attractively valued and now shunned by overseas investors.”
“So for now we are keeping our exposure to Japan largely intact, relieved that any setbacks there have been offset by gains in our index-linked bonds and gold.”
Russell and Ballance have managed the £2.9bn CF Ruffer Total Return fund since October 2006.
They are renowned for protected capital in more difficult market conditions, which although has meant they have underperformed in a relative basis during bull-runs, their fund has been one of the best performers in the IA Mixed Investment 20%-60% Shares sector under their stewardship.
Performance of fund versus sector and benchmark under Russell & Balance
Source: FE Analytics
FE data shows the fund has returned 95.44 per cent since they took over, compared to a 36.63 per cent gain from its average peer and a 63.92 per cent rise in its composite benchmark – the FTSE All Share and FTSE British Government All Stocks 50/50 spilt.
Most of that outperformance came during the crisis years. As a matter of fact, it is underperforming over one and three years.
Currently, the managers hold 43 per cent index-linked bonds and 8 per cent in gold due to their view that inflation will increase over time. The rest of the portfolio is split across equities, cash and illiquid strategies.
